2023-05-04 12:37:18 ET
Summary
- CONSOL's management has implemented a marketing strategy that involves shifting towards exports and increasing volume growth.
- Since 2020, the company has reduced its domestic market portfolio from 57.6% to 41.4% in 2022, while boosting its exports from 42.4% to 58.6%.
- By using windfall cash to reduce debt levels, CONSOL Energy was able to decrease its dependence on the capital market and improve shareholder return opportunities.
Introduction
CONSOL Energy (CEIX) is a thermal coal energy producer with a growing sales presence in Europe and Asia. In response to the expected decline in coal consumption in the US, the company has shifted its focus to exporting, which has strengthened its balance sheet and provided long-term returns for shareholders through capital returns. CONSOL generated a significant amount of operating cash flow last year, largely due to higher-than-expected coal prices, which translated into free cash flow. By reducing its debt levels, the company has improved its leverage and liquidity conditions, allowing it to allocate 35%-50% of its quarterly FCF towards returning value to shareholders through dividends or share buybacks during 2023.
CONSOL performance and 2023 outlook
CONSOL Energy, a fossil fuel energy producer, benefited greatly from Russia's conflict with Ukraine. Despite the devastating consequences of war, the resulting shortage in fossil fuel supply caused prices to rise globally. As a thermal coal company, CONSOL was able to generate significant profits from this situation. Russia is one of the largest coal exporters in the world, but due to current circumstances, finding buyers for its energy products has become difficult. This presents an opportunity for other producers to increase their production and export levels. Fortunately, CONSOL's management has implemented a marketing strategy that involves shifting towards exports and increasing volume growth. Since 2020, the company has reduced its domestic market portfolio from 57.6% to 41.4% in 2022 while boosting its exports from 42.4% to 58.6%. Looking ahead, even if coal demand falls in the United States up to 2030, CONSOL will be able to optimize its portfolio by focusing on the export market.
In 2022, CONSOL Energy prioritized strengthening its balance sheet and providing long-term returns to shareholders through capital returns. The company effectively utilized the windfall cash to pay off obligations and reduce debt levels. By not having near-term maturity debts, CONSOL Energy was able to decrease its dependence on the capital market and improve shareholder return opportunities. In the first quarter of 2023, CONSOL Energy's net debt level hit its lowest point at $38 million, which is well below their cash balance of $268 million and will soon be eliminated. The company's operating cash generation increased significantly to $248.5 million in 1Q 2023 compared to $151 million at the end of 2022, resulting in a substantial amount of free cash flow of $214.7 million. This amount is significantly higher than the previous quarter's free cash flow of $114 million and the first quarter of 2022's free cash flow of $111 million. Ultimately, CONSOL Energy has no difficulty fulfilling its target program of allocating 35%-50% of quarterly FCF towards dividends and share buybacks for shareholders.
Figure 1 - CONSOL cash and capital structures (in millions)
The LNG supply-demand gap that has emerged since 2020 highlights the urgent need to increase supply and meet LNG demand. This issue would support coal demand around the world (see Figure 2). Europe is importing a good amount of coal from the US, and although the coals prices will not be as strong as in 2022 due to the previous warmer-than-expected winter and thus full LNG stores, global coals are still expected to remain attractive, and thus their price will remain at good levels, according to S&P global . Notwithstanding lower coal consumption in the US, the United States is expected to increase its coal exports by 7.9% in 2023 as compared to 2022. In this regard, thermal coal exports may boost by approximately 12% to 4 million short tons during 2023.
Figure 2 - LNG supply-demand gap
Consol Energy 1Q 2023 presentation
In 2023, the company plans to maintain its capital expenditures within the range of $160-$185 million, which will result in a significant amount of free cash flow for the following year. This surplus cash flow will be utilized to reduce debt and improve leverage, as per the management's target. Therefore, it is helpful to assess the company's leverage condition. During 4Q 2022, CONSOL Energy recorded an EBITDA of over $335 million, which was 10% higher than the previous quarter. However, this amount was influenced by abnormal coal prices in 2022 and is unlikely to be repeated this year. Nevertheless, an analysis of CEIX's balance sheet structure suggests that the management can efficiently enhance leverage conditions by reducing debt levels. The company has already demonstrated a decreasing trend in its leverage ratios over the past year.
Furthermore, CEIX's other leverage ratios indicate an improved financial position. The interest coverage ratio has significantly improved and reached its highest level of 26.7x in 1Q 2023. This indicates that CONSOL Energy can easily pay back interest on its outstanding debt and has no current liquidity issues. Finally, in 1Q 2023, the equity level surged by over 91% to $1281 million compared to 1Q 2022. This caused a drop in net debt-to-equity level to 0.03x in 1Q 2023 (see Figure 3).
Figure 3 - CEIX's leverage condition
Risks
In addition to maintaining strong financial structures, investors must also monitor CONSOL Energy's potential risks, both market-related and operation-related. One significant risk is the volatility and fluctuation of coal prices due to the trend of eliminating coal-fired generation facilities in developed and developing countries. Another risk is related to regulations and policies surrounding pollution and climate change, which can negatively impact the company's operating costs and market for coal. Consol Energy also has long-term contracts with various consumers, making them vulnerable to global economic conditions or a worldwide financial downturn that could affect their liquidity, operations, and cash flows. For example, weakened demand for electricity due to decreased industrial production could lead to declining revenues, margins, and profitability for the coal business.
Conclusion
In this through analysis, I investigated CONSOL Energy's financial performance during the last year and the first quarter of 2023, while anticipating its financial conditions in 2023. Although the nature of the coal industry is to be volatile, the company has done its best to improve its solvency and leverage conditions by decreasing its debt level. Also, a well amount of free cash flow generation would increase capital returns for shareholders. When all was said and done, CONSOL Energy's financial performance in the preceding year caused me to believe that the stock is a buy.
For further details see:
Consol Energy: Improved Leverage Condition Brings Opportunity For Shareholder Returns